Canada cannot fully insulate itself from a U.S. fiscal crisis, but it can enhance its resilience — and it should begin preparations immediately. While Canada's own public debts are high yet manageable, the United States is on an unsustainable fiscal trajectory that poses grave risks to its northern neighbor.
Canada's Debt: Manageable but Not Trivial
Ottawa and the provinces face real fiscal pressures from healthcare, an aging population, defense obligations, and weak productivity growth. However, Canada's fiscal problem remains manageable. As long as policy follows pre-COVID patterns, Canada has time to adjust. The situation is serious but far less dangerous than the unfolding crisis in the United States.
The U.S. Fiscal Arithmetic
The United States is running large, persistent primary deficits — tax revenues do not cover regular government expenditures, let alone interest payments. Federal debt already exceeds 100% of GDP and is projected to keep rising. Without serious fiscal reform, the debt-to-GDP ratio will not merely drift upward; under plausible assumptions about interest rates and growth, it will rise without bound. This is not alarmism; it is arithmetic.
Debt dynamics depend on three forces: the interest rate on debt, the economy's growth rate, and the primary balance (taxes minus non-interest spending). A country can live with high debt if growth is strong, interest rates are low, and primary deficits are small. But persistent large primary deficits eventually dominate the equation. Low interest rates help but do not repeal the arithmetic.
The Doom Loop Risk
There is no magic debt threshold at which crisis suddenly strikes. However, the more debt a country carries relative to GDP, the greater the risk of a doom loop. At some point, investors worry about sustainability. Borrowing costs rise, higher interest payments add to deficits, larger deficits push borrowing costs even higher, growth falters, revenues fall, and fiscal stress intensifies.
This logic applies even to the United States. The world's appetite for dollars and the depth of U.S. financial markets reduce the risk of a crisis and give the U.S. more room to maneuver than most countries have. But even the U.S. is subject to the dictates of fiscal arithmetic.
Can the U.S. Fix Its Fiscal Problem?
Yes, but the federal budget is dominated by protected categories such as Social Security, health, defense, interest payments, and other mandatory spending. Stabilizing the debt would require large spending cuts or tax increases, or both. Raising taxes to Canadian levels would help, but there is little evidence the U.S. political system could make such changes on the required scale. A temporary tax hike might be possible in the face of an impending crisis but would only buy time to implement more difficult permanent reforms before another crisis.
Why Canadians Should Care
Canadians may be tempted to treat this as an American problem. That would be a mistake. Canada cannot be fiscally safe if its largest trading partner and the center of the global financial system is not. A U.S. fiscal crisis would have grave consequences for Canada, and Canadians should start preparing now.
